These 5 factors are changing the Indian economy

It has been reported that The Equity markets globally have witnessed an incessant rally, driven initially by attractive valuations, and thereafter by the excessive liquidity infused by central banks globally to stabilise respective economies.

In recent months, the Indian equity market has considerably outperformed global markets and is presently quoting at valuations which are well above its mean, and at a higher premium to other emerging markets than that witnessed historically. What should investors now watch out for as leading economic indicators in the near future?

Inflation

We have been witnessing a high level of inflation in the prices of global commodities. Besides excess liquidity, the other reason is the demand-supply scenario, with global economic growth looking up and bottlenecks on the supply front. Recent developments in China have, however, resulted in a cooling-off in the prices of metals.

While historically Indian corporates have fared better in a slightly inflationary environment in terms of the absolute growth in topline and bottomline, we are presently witnessing an impact on profitability as the rise in input costs has been faster and greater than the improvement in demand.

While we have historically seen a positive correlation between crude prices and Indian equity indices due to inflows in risk assets, this may not necessarily hold true if crude prices reach such excessively high levels that they begin to impact overall growth negatively, the company said.

Consumer Demand

Consumer demand is impacted by the economic well-being and sentiment of individual consumers. We had witnessed job-losses last year; however, with a revival in overall growth in the present year, concerns on this front are lesser, though there could still be some pain in the unorganized sector. On the rural front, we had a reasonable monsoon.

There hasn’t been any sign of a third wave in India post the economy opening up, thus alleviating concerns in this regard: this should result in an increased consumer demand, the company said.

Interest Rates

The trend in interest rates globally is expected to have an impact on interest rates in India. Leading global central bankers have been mentioning inflation as transient, but this stance could be already changing. Leading central banks appear to be preparing markets for eventual rate hikes post the planned tapering of liquidity. We could witness a similar scenario in India as well, the company said.

Government Actions

One of the additional drivers of the Indian equity market during this calendar year has been the Government’s intent to spend on growth for 3 more years by indicating a relatively high fiscal deficit even beyond the present financial year. With monetary policy normalising, the onus would shift to the fiscal policy of the government to support growth over the next couple of years.

The success of the disinvestment agenda would be a key indicator to watch out for over the next 12-18 months, the company said.

Investor Flows

A favourable current account position, some of the initiatives from the Government, a strong GDP growth, and a strong earnings growth expectation over the next 2 years, has contributed to flows from all segments of investors since the past year.

Historically we have seen allocation-shifts by FII between various markets, withdrawing partially after periods of sustained outperformance by any particular market. The US dollar is expected to strengthen against a basket of currencies, including the Indian rupee and this too could be a dampener for FII flows in the near-term.

A greater formalisation of the economy over the past few years, options for retail investors to participate in the growth of consumer-internet companies, and future listings of mega market-cap companies could mean the Indian equity market trending higher in terms of percentage of global market-cap, so the longer-term prospects continue to be positive, the company said.

Equity markets are generally driven by four factors: Fundamentals, valuations, sentiment and liquidity. Presently, fundamentals and sentiment are positively inclined, while valuations and liquidity presently do not appear to be as favourable. Therefore, while strong 2-year earnings growth prospects drive our positive outlook for the equity market, the near-term outlook is cautious, and the focus could now shift much more towards specific stocks. (Money Control)